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Please tell me where I go wrong here, because this is something I’ve been worried about for a long time. So much so, in fact, that I call it my “nightmare scenario.”

It might be unlikely, but legally, am I wrong to worry about this? And if legally correct, what’s the best argument about why I shouldn’t worry about it.

Here goes:

A business development executive—read, sales person—is traveling to…the location changes in my nightmare, sometimes Azerbaijan, sometimes Kazakhstan…and is stopped at Customs. The Customs Official has his hand out, saying that there’s a new tax on entry, $5 US dollars. The sales guy pays the $5 bucks, and sees the Customs Agent put the money into his pocket. Having had his passport stamped, he doesn’t really care. But he wants his $5 back, so when he fills out his expense reimbursement form, he says that he spent $5 on tips. It’s not entirely inaccurate, he figures.

Now we’re off to the races.

Under Kazakh or Azeri law, Customs Agents have the theoretical power to turn people away at the border. What that means, for those people who are always wondering exactly what a “facilitation payment” is, is that this isn’t a facilitation payment. The best demarcation point for facilitation payments is discretion. If what you’re looking for is discretionary action—getting someone to decide your way when the decision could go either way—and you pay for it, it’s a bribe. So that $5 payment, it’s a bribe, not a facilitation payment. So we have an FCPA violation, albeit a minor one.

But it’s the violation that matters. Because let’s spend some time talking about what “material” means, in the context of financial misstatements. Corporations must disclose material misstatements.

As a “rule of thumb,” corporations generally paint errors of less than 5% of income as immaterial. That’s not the definition, however, and the SEC made it clear—read Staff Accounting Bulletin 99—that “materiality” is about more than just percentages. The SEC laid out a non-exhaustive number of considerations for when a small misstatement is transformed into a material one:

whether the misstatement arises from an item capable of precise measurement or whether it arises from an estimate and, if so, the degree of imprecision inherent in the estimate

whether the misstatement masks a change in earnings or other trends

whether the misstatement hides a failure to meet analysts’ consensus expectations for the enterprise

whether the misstatement changes a loss into income or vice versa

whether the misstatement concerns a segment or other portion of the registrant’s business that has been identified as playing a significant role in the registrant’s operations or profitability

whether the misstatement affects the registrant’s compliance with regulatory requirements

whether the misstatement affects the registrant’s compliance with loan covenants or other contractual requirements

whether the misstatement has the effect of increasing management’s compensation – for example, by satisfying requirements for the award of bonuses or other forms of incentive compensation

whether the misstatement involves concealment of an unlawful transaction.

I’ve put into bold the two that most concern me. Because the FCPA is a regulatory requirement, and the payment to the Kazakh/Azeri official is an unlawful transaction.

Does this mean that every FCPA violation, no matter how small, is a material event in the life of a company?

Because let’s bring in something else. Right now, companies get credit for self-disclosure. But the rules around self-disclosure aren’t without limits. They’re cabined by factors which make the disclosure less-than-voluntary. For example, if you get a call from the Wall Street Journal asking for comment on a bribery accusation to appear the next day, and you run into the DOJ, that’s not a “voluntary” disclosure. Wouldn’t that also mean that if a company were required by regulation to disclose—say, if there were a requirement to disclose material misstatements in an SEC form—wouldn’t that mean that disclosures pursuant to that requirement wouldn’t be “voluntary” for purposes of the self-disclosure credit? I would think so.

The form that companies use to disclose material events is an 8-K. It’s an out-of-cycle disclosure form for events that won’t wait for the next 10-Q or 10-K. They matter. The market cares about 8-Ks. So now we’re talking about a corporation having to file an 8-K disclosing a $5 payment in Kazakhstan. That’s what I call a “stock price event.”

All because of a $5 payment.

That’s my nightmare.

Now, we haven’t seen cases based on this kind of thing. But we contrive controls not based on the enforcement record, but on our perception of the risk. I couldn’t in good faith recommend that you set up controls to cover this, but it’s something to think about.

Please, help me sleep: where am I wrong about all this?

Post Script: Mike Volkov and I are subconsciously on the same wavelength lately. I write about the Compliance Defense, he writes about the compliance defense. Now, I write this about a problem with customs, and he writes on the problems with customs. Weird.

4 Responses to “The Nightmare Scenario”

Disclosure requirments do not exist in the abstract. The requirements exist so that shareholders and investors have access to reliable, meaningful information about an issuer. Would you buy or sell this company’s stock if you knew about the $5 payment? The reasonable person’s answer has to be “no”. Accordingly, the fact is not material and need not be disclosed.

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